David Jones party over, but hangover lingers

The hangover from
David Jones
’s 175th anniversary party is kicking in for chief executive
Paul Zahra
, who has a ­problem to add to the long list keeping him awake at night.

An unseasonably hot start to winter, when department stores usually rake in sales of big-ticket items such as coats, has put a ­dampener on David Jones’s third quarter sales results.

Remarkably, given the reporting period covered the autumn months leading up to May, swim-wear was the company’s best performing product.

If that does not confirm the unpredictable nature of the Australian retail sector then nothing does.

AFR
AFR

The margins on a bikini just do not stack up compared to what a department store can make on selling a winter coat, so Zahra and other retailers are praying for a cold spell to clear stock.

This is not as big an issue for David Jones as retailers like
Wesfarmers
-owned
Target
, which is struggling to clear a 16 per cent jump in inventories in the March quarter. David Jones has taken a more disciplined approach to managing its inventories, which is paying off as it reduces the pressure to discount heavily to clear stock.

This is at the heart of Zahra’s strategy, which he was forced to defend on Monday after David Jones’s shares initially fell almost 5 per cent on a disappointing 3.4 per cent drop in like-for-like sales.

Zahra remains confident his plan to stop the endless discounting and focus on improving gross profit margins will translate into higher shareholder returns further down the track.

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Zahra still to prove himself

It is a different approach to rival
Myer
, which is focused on driving sales growth. Sacrificing sales in an environment where consumer sentiment is short is a risky strategy. Even Zahra acknowledged David Jones was walking a fine line as he manages the company through complex times.

The jury is still out on Zahra, who inherited the job suddenly at a tough time in 2010 after his predecessor
Mark McInnes
had to step down.

While David Jones’s champagne-fuelled party last week harked back to the group’s glory days, Zahra has acknowledged the company needs to move with the times by fixing its service, adapting to technological change and taking on board more exclusive brands.

Like its main competitor, David Jones faces myriad structural challenges from the growth in on-line shopping (which still only accounts for 1 per cent of its sales), increased competition and weak consumer sentiment.

There were other factors at play in the lacklustre sales results. Home electronics was the biggest deficit in the decline as it works to clear its stocks of games and DVDs, low-margin products it is seeking to exit.

It can also no longer rely on big-ticket new technology products, such as Apple tablets, to drive sales, although Zahra has been assured there will be some whiz-bang new items on the market in 2014.

Consumer sentiment is also gloomy. This is a nightmare for a company like David Jones that has a history of performance when sentiment is at its highest.

Spending declined sharply in March and April but the company recorded its best-ever week last week which coincided with a cold snap and a blaze of publicity around the anniversary party.

Consumer confidence falls

The Westpac-Melbourne Institute Consumer Sentiment Index for May fell 7 per cent, alarming retailers, particularly as it was the first read of consumer sentiment after the Reserve Bank’s last rate cut. David Jones’s customers are traditionally regarded as well-heeled, and know that rising house prices and a pick-up in equity markets may not translate into the kind of economic conditions needed to justify a shopping spree.

The company’s focus on high-margin categories, such as womenswear and cosmetics, should deliver results if sentiment improves but it is hard to see that happening any time soon and certainly not before the September election.

Zahra is also investing in internet capability, new point-of-sale systems, new brands, new credit cards, refurbished stores and harmonisation of in-store and online prices. The company is launching China UnionPay in its stores which will be an important tool for capitalising on the growing number of Chinese visitors to Australia.

Sentiment picked up later on Monday with David Jones shares closing down only 2¢, while Myer was in a similar boat.

GrainCorp takeover

There is always a risk that even the most sensible of commercial transactions will be hijacked by politics in an election year.

The $3 billion takeover of one of the nation’s last big listed agri-businesses ­GrainCorp, by US giant Archer Daniels Midland (ADM), is one case in point, although the deal is more likely to be approved by ­regulators than not.

As you would expect, the farmers’ lobby groups has seized on the pending change of ownership in GrainCorp to advance their case for better access to east coast grain export terminals and storage sites.

This is not new. Farmers’ groups have been seeking changes for decades. They are quite rightly seeking assurances they will not be worse off when the assets fall into ADM’s hands.

However, they privately know their efforts to force ADM to sell ports and give cast-iron long-term guarantees around access to storage infrastructure is unlikely to be successful.

GrainCorp owns seven of eastern Australia’s eight grain export terminals and 280 storage sites. Despite its dominance, there should be no competition issues around ADM’s bid as the US firm does not currently own any other Australian infrastructure.

The GrainCorp infrastructure must adhere to an open-access regime overseen by the Australian Competition and ­Consumer Commission (ACCC).

That legal frameworks remains in place under a change of ownership. Farmers ­correctly argue there is no guarantee about future access, but to burden GrainCorp-ADM with more regulation because of a change of ownership would be sending the wrong message to foreign investors.

Many of Australia’s ports are already owned by foreign interests, although you could argue that is good reason on its own for regulators to have a good look at this deal.

The identity of GrainCorp’s bidder, a listed US firm, also means it is likely to generate less political anxiety than if it was a state-owned firm like the Singapore Exchange which had its bid for Australia’s ASX knocked back by the Treasurer in 2011.

It is unusual for a company from the US, which has a good relationship with Australia, to be knocked back by FIRB.

There has been a lot less noise so far around a $5 billion bid by China’s State Grid for Singapore Power’s Australian assets, which include two of Australia’s big three energy utility companies.

Well aware of the political ramifications of making a hostile bid for GrainCorp in an election year, ADM worked towards an agreed deal with the target’s board.

It will also argue that half of GrainCorp is already owned by foreign interests, if you take into account the hedge funds that jumped on board when ADM made its initial offer. Expect a lot more noise on the issue when a Senate committee inquiry into the operations of bulk handlers and wheat export arrangements gets under way.

Liberal senator and wheat grower
Bill Heffernan
is leading the inquiry, the fourth time a Senate committee has looked into the issue since the wheat market’s deregulation in 2008.

Heffernan knows he has to tread carefully to make sure the separate inquiry he is chairing into FIRB itself that is due to report on June 24 is not compromised by the Senate inquiry. However, it is a good opportunity to get all the issues back on the table.

More will be known about ADM’s intentions when it finishes due diligence and releases its bidders’ statement next month.